Regulation remains a problem

In his policy speech to the Diet earlier this year, Prime Minister Junichiro Koizumi announced that the government would double foreign direct investment in Japan in five years to increase employment.

The outstanding balance of foreign direct investment in Japan is only one-sixth that of the country’s direct investment overseas. The balance of foreign direct investment in the United States exceeds that of U.S. investment in other countries. In Britain, Germany and France, the inward foreign-investment balance is about half the amount of the outward foreign-investment balance.

As a result, foreign direct investment in Japan accounts for only 1 percent of total employment, compared with about 5 percent in the U.S. and Germany.

Last month, the government’s Japan Investment Council announced a “Program to Double Foreign Direct Investment.” The program focuses mainly on the barriers faced by foreign companies in entering the Japanese market. However, there is a more fundamental problem associated with doing business in Japan — one that causes even domestic companies to shift operations overseas.

Chihiro Kanagawa, president of Shin-Etsu Chemical Co., says that he would like to make new investments in Japan to prevent an outflow of technology, but says doing so does not pay because of high costs associated with the price of industrial land, power rates, wages, transportation and taxes. Foreign companies considering making investments in Japan would face the same problems.

A survey by the Economy, Trade and Industry Ministry shows that the cost of services for industries in Japan is 2.7 times higher than in the U.S., 2.2 times higher than in Germany and nine times higher than in China. Airport usage charges in Japan are 2.5 times higher than in the U.S.

High costs in Japan often reflect outdated regulations. An item-by-item study of the government’s list of proposed deregulation reveals both an alarming multitude of regulations and the slow pace of the deregulation process.

The government says it plans to open the nation’s seaports 24 hours a day as soon as possible, but high costs and red tape in Japan have already driven distribution bases to neighboring countries. The total cost of seaport usage in Japan is said to be four to 10 times as high as that in Singapore.

The government has also proposed to reactivate local economies by developing clusters of IT industries, but Japanese and other Asian companies have already been moving to set up plants in similar clusters in China’s Pearl River Delta and elsewhere. Japanese manufacturers’ moves to shift production bases overseas are leading to a decline of clusters of smaller high-tech companies in Tokyo and Higashi-Osaka, which have long supported Japan’s electronic and other industries.

The barriers foreign companies face in entering the Japanese market are often the remnants of the “liberalization countermeasures” on foreign capital that were made in the 1960s, when Japan joined the Organization for Economic Cooperation and Development.

At that time, the government, wary of foreign companies’ takeover attempts, set limits on foreign investors’ stock ownership in Japanese companies. Even in cases where applications for establishing companies would have been automatically approved under existing law, foreign companies were required to obtain advance authorization of automatic approval. Twelve criteria were applied on the procedure, such as “there should be no adverse effects on Japan’s interests.”

Existing regulations and the government’s stance reflect these liberalization countermeasures. It is only natural that foreign companies should regard them as barriers. The European Business Community in Japan says that a decision on entering the market is complicated by regulatory authorities’ detailed “guidance” on product approval, complicated application procedures, government-procurement procedures that exclude competition, and a lack of transparency in regulation.

The government’s Japan Investment Council, established in 1994 to encourage foreign investment in Japan and chaired by the prime minister himself, has issued a series of statements inviting foreign investment. Last month, it announced the government would do its best to encourage foreign investment in Japan. I am not optimistic about this promise.

The program includes plans to modify administrative procedures, facilitate mergers and acquisitions, promote the employment of foreigners and improve their living environment. These are essentially aimed at removing problems faced by foreign companies. However, the program fails to address the basic problems for foreign as well as Japanese companies such as high costs, the tax system and regulations.

At a meeting of the Japan Investment Council, Osaka Gov. Fusae Ota noted that as an incentive for foreign capital, her prefecture is cutting the local corporate enterprise tax by 90 percent for new companies for five years, and insisted on a cut in the national corporation tax. However, the council’s program only mentioned that some have pointed out that tax is an important consideration for companies selecting investment sites, and noted that the investment environment, including the tax system, “should be reviewed as required.”

In the fiscal 2003 tax reform, the proposed cut in the national corporation tax was shelved. Instead a factor-based local corporate tax on capital and wages was introduced. The American Chamber of Commerce in Japan had warned the Japanese government of its adverse impact on foreign direct investment and on the Japanese economy. The Koizumi administration, while calling for an increase in foreign direct investment in Japan, is implementing policies that would hinder such investment.

The World Economic Forum’s Global Competitiveness Report for 2002, based on technology, public institutions and the macroeconomic environment, showed that Japan ranked 13th among 80 countries in overall competitiveness. It ranked fifth in terms of technology, with the report saying Japanese companies are competitive in innovation. Japan was 25th in public institutions and 29th in macroeconomic environment.

All this means that Japan’s problem is more with the government than with businesses. Koizumi administration has failed in its responsibility to improve Japan’s investment environment to meet the needs of the global economy.

I suspect this is a result of the administration’s perception of the nature of the current economic stagnation. Heizo Takenaka, a central figure of Koizumi’s economic team as financial, economic and fiscal policy minister, says that the problem is not the supply-demand gap and that deflation is a domestic monetary phenomenon. This suggests that price hikes through monetary policy take priority over improvement of the investment environment aimed at expanding private demand to close the supply-demand gap.

Koizumi’s announcement to double foreign direct investment in Japan should provide us with an opportunity to reappraise perceptions of the nature of stagnation and structural reforms. Reappraisals should be made with a view to restoring Japan’s international competitiveness. Individual reform proposals must be given a proper place in this context.